Of course, those of you who have been trading for a while have heard of this terminology.
Those of you who are just starting to trade may not have been. But it’s time for you to learn one of the terms that are often circulated in the trading world.
So, what is liquidity?
A currency pair is considered to have a high level of liquidity when it can be bought or sold easily, and there is a large amount of transaction activity for the pair.
Usually, liquidity is calculated by taking the transaction volume or the volume of transactions currently pending in the market.
Liquidity is a key factor to be able to make profitable transactions. Greater liquidity in financial markets eases the flow of transactions and makes prices more competitive.
It can be concluded that liquidity in Forex trading allows traders to easily make transactions, thereby affecting the popularity of a market.
Not all currency pairs are liquid.
Currency pairs tend to have varying degrees of liquidity depending on whether they are major, minor and exotic pairs (whether they are emerging market currencies). Forex liquidity can recede, for example when traders move from major pairs to minor pairs, and finally to exotic pairs.
Liquidity also has the peculiarity of measuring how quickly an asset buyer can convert cash into tangible assets.
In a highly liquid market, a person who wants to buy an asset that has a fundamental value of $100 will be able to buy that asset instantly for $100, and he or she receives the asset instantly.
Liquidity has a large impact on the level of market volatility.
Lower liquidity usually results in a more volatile market and has the potential to cause prices to change drastically.
Meanwhile, higher liquidity usually creates a less volatile market where prices do not fluctuate drastically.
Volatile markets generally occur when the market rises and falls more than one percent in a day over a sustained period of time.
Considerably high liquidity can be seen from currency pairs that can be bought/sold in significant sizes without large differences in exchange rates, for example in Forex trading, major currency pairs such as EUR/USD.
Other major currency pairs that are considered highly liquid are:
Meanwhile, low liquidity in forex refers to currency pairs that cannot be bought/sold in a significant measure without large variations in their exchange rates, for example exotic currency pairs such as PLN/JPY.
The Importance of Liquidity in Forex Trading
If the market is not liquid, it will be difficult to sell or convert assets or securities into cash.
For example, you have an asset that is very rare and of very high value. Let’s say you set a price of IDR 5 billion. However, if there is no market (aka no buyer) for your assets, then your assets become irrelevant because no one is willing to pay.
This means that your assets are highly illiquid.
You may need the services of an auction house to act as a broker and track potential interested parties, which can be time-consuming and incur costs.
Liquid assets can be easily and quickly sold, and cost very little.
Learn the fees that are charged to traders for each transaction made.
From the corporate side, a company must have sufficient liquid assets to cover short-term liabilities such as bills, payroll expenses, or to deal with a liquidity crisis, which can lead to bankruptcy.